SentinelOne: Improving Margins Should Support The Stock
Summary
- SentinelOne is registering strong growth and improving margins, despite general macro weakness. Within SaaS, security continues to be one of the better performing segments.
- There is execution risk associated with SentinelOne's move upmarket, and a growing threat from CrowdStrike's increased focus on the SMB segment.
- SentinelOne's valuation is low, as investors are prioritizing profits above all else. Robust growth and improving margins could drive strong returns over a multi-year period, albeit with high volatility.
Just_Super
SentinelOne (NYSE:S) continues to grow rapidly, and with an increased focus on the bottomline, is beginning to demonstrate significant operating leverage. This should be supportive of the stock price going forward, particularly as there is a limit to how much further multiples can compress, absent a recession.
Market
Commentary by SentinelOne’s management suggested that market conditions did not change significantly in the fourth quarter. Customers continue to be conscious of costs and IT budgets are under pressure, causing deal cycles to lengthen. This is a situation that SentinelOne is expecting to continue going forward. Despite this, endpoint, cloud, identity and data security remain top IT spending priorities, which should limit the extent to which growth decelerates in 2024 for security vendors. This is supported by CrowdStrike's (CRWD) management, who stated that demand was fantastic in January.
Hiring for endpoint and cloud security positions appears to have stabilized in recent months, which may also suggest that the market has found a temporary bottom.
Figure 1: Job Openings Mentioning Cloud Security in the Job Requirements (source: Revealera.com)
Figure 2: Job Openings Mentioning Endpoint Security in the Job Requirements (source: Revealera.com)
SentinelOne
SentinelOne offers a broad platform that addresses endpoint, cloud, identity and data security. This allows customers to consolidate point solutions, improving security and reducing the total cost of ownership. Cost savings, are in part the result of SentinelOne's extensive use of automation, which helps to lower the burden of managing security operations. As a result, SentinelOne offers a better value platform, without significantly increasing costs. Although, if customers opt for more advanced capabilities, beyond the core endpoint solution, costs can rise substantially.
Cloud security is a focus for SentinelOne, and should be supportive of growth going forward, as the number of cloud workloads that need protection will likely exceed the number of employees at any enterprise. SentinelOne's Singularity Cloud is easy to deploy, non-invasive and utilizes the same AI-based behavioral detection modules as their endpoint solution. Despite this, awareness is currently relatively low, although it's increasing on the back of a rising number of cloud-based attacks. SentinelOne recently partnered with Wiz to support its cloud business and provide customers with more comprehensive cloud protection. Wiz is a leader in cloud security posture management.
SentinelOne’s product development efforts are focused on strengthening its endpoint and cloud security solutions and extending the capabilities of its platform (security data lake, identity security, and vulnerability management). Singularity Cloud is SentinelOne's fastest growing solution, with data retention, vigilance MDR and identity security also performing well. In comparison, within CrowdStrike’s emerging product category, Identity and LogScale have been performing particularly well.
SentinelOne's win rates improved in the fourth quarter, including against large next-gen vendors. Presumably this would primarily refer to CrowdStrike or Palo Alto Networks (PANW). SentinelOne’s management has stated that they are winning in a significant majority of competitive situations, and in particular, highlighted an increasing number of Microsoft (MSFT) displacements. ASPs have so far remained stable, indicating that the demand environment may not have deteriorated too much so far.
SentinelOne believes that its partner friendly go-to-market approach is a competitive differentiator, particularly when it comes to MSSPs. This could be important as CrowdStrike is currently trying to expand their presence in the SMB segment, and this is being driven in large part through greater utilization of MSSPs. SentinelOne also offers capabilities like multi-tenancy, automation and role-based access control which are potentially beneficial to MSSPs.
Financial Analysis
SentinelOne's performance in the fourth quarter was quite strong, particularly given general weakness in SaaS. Cloud security contributed approximately 15% of quarterly ACV, more than doubling QoQ. In comparison, CrowdStrike's cloud business registered YoY ARR growth in excess of 100%, albeit off a much larger base. SentinelOne's pipeline also remains strong, nearly doubling YoY, and win rates have been increasing.
ARR increased by 88% YoY in the fourth quarter and is expected to increase by around 50% in FY2024. SentinelOne's management has guided to 75% YoY revenue growth in the next quarter and 51% revenue growth in the coming year. This guidance could be considered conservative as management has suggested that macro uncertainty is making them more prudent in regards to guidance.
Figure 3: SentinelOne Revenue Growth (source: Created by author using data from company reports)
Customer acquisition continues to be reasonably strong, particularly amongst larger customers, which is in line with SentinelOne's expansion up market. SentinelOne's large customer count increased by 74% YoY in the fourth quarter. They also added a record number of Global 2000 organizations.
Figure 4: SentinelOne Customers (source: Created by author using data from SentinelOne)
Search interest for "SentinelOne Pricing" remains strong. This could be interpreted as bullish if it indicates increased demand for SentinelOne's platform, although it may also represent greater customer concern regarding pricing. Given the surges in early 2020 and late 2022, it would appear that cost concerns are driving this metric.
Figure 5: "SentinelOne Pricing" Search Interest (source: Created by author using data from Google Trends)
SentinelOne's gross retention rate improved sequentially in the fourth quarter, indicating that competition and macro pressures remain manageable. SentinelOne's net retention rate is also still fairly robust, although it has eased somewhat in recent quarters. Expansion is being driven by an increasing number of endpoints/workloads and module adoption. Emerging capabilities contributed over one-third of SentinelOne's bookings in FY2023. Adoption of modules is also becoming an important driver of growth in the MSSP channel.
Figure 6: SentinelOne Net Retention Rate (source: Created by author using data from SentinelOne)
SentinelOne's gross profit margins continue to improve, although they are still below management's long-term target (75-80%). SentinelOne recently signed a new agreement with one of their cloud hosting vendors, which should improve margins going forward. Data processing efficiencies driven by Scalyr should also support gross margins in the future. Non-GAAP gross margins are expected to be approximately 74% in FY2024, up 2% YoY.
Figure 7: SentinelOne Gross Profit Margins (source: Created by author using data from company reports)
Non-GAAP operating profit margins are expected to be in the negative 25-29% range in FY2024. Improvements are expected to be driven by ongoing growth, greater salesforce productivity and a moderation of R&D investments.
SentinelOne's employee retention is roughly 10% better than industry average, which holds true within the sales organization. Over time, this should be supportive of lower employee expenses and greater productivity.
Figure 8: SentinelOne Operating Profit Margins (source: Created by author using data from company reports)
Sales and marketing and general and administrative expenses continue to be elevated. The burden of sales and marketing expenses should decline significantly over time as growth moderates though.
Operating costs are also currently elevated due to the amortization of SBC expenses from when SentinelOne's stock price was high in 2021. While SBC cannot be ignored, these expenses do not reflect the current reality.
Figure 9: SentinelOne Operating Expenses (source: Created by author using data from SentinelOne)
SentinelOne's hiring is still quite strong relative to most SaaS peers. This could indicate that management is relatively confident in 2024's projections, but this hiring will also likely limit margin improvements.
Figure 10: SentinelOne Job Openings (source: Revealera.com)
Valuation
SentinelOne's valuation continues to be well below what would be expected for a leading SaaS company achieving high double digit growth. This is likely due to SentinelOne's large losses and general macro concerns. While there is a significant risk that SentinelOne fails to establish itself as one of the leaders in the endpoint and cloud security market, the stock is currently pricing in limited growth/profitability in the future.
Figure 11: SentinelOne Relative Valuation (source: Created by author using data from Seeking Alpha)
This article was written by
Disclosure: I/we have a beneficial long position in the shares of S, CRWD either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.